“Hardly anything is more important than behaving well as you go through life.”
Berkshire Hathaway AGM 2015 – Pender’s Key Take Away Thoughts (Part 2)
We attended the Berkshire Hathaway 2015 Annual Meeting in Omaha. We like to hear first hand from two of our value investing icons. We took away four key thoughts. This is the second.
“Hardly anything is more important than behaving well as you go through life.” – Charlie Munger
At the Berkshire Hathaway AGM, a number of questions revolved around the subjects of reputation and culture. Maintaining a good reputation is very important and can only be built up over time, one grain of sand at a time. Buffett said he was once told that “When you get old, you will get the reputation you deserve” and said Berkshire has benefited a great deal from its reputation. Historically, Berkshire has focused on acquiring strong, well run businesses and has left the existing management in place. The idea of investing in “turnarounds” has never held much appeal at Berkshire. That may be slowly changing at least indirectly, if not directly (yet).
In recent years, Berkshire has increasingly partnered with 3G, a Brazilian led private equity group, who has established a strong track record generating high returns in the turnarounds of large, well-known companies. Berkshire’s involvement with this group was a source of a lot of questions and uneasiness amongst many in the crowd because their model is different to the one Berkshire has historically used.
3G typically buys controlling ownership of poorly run firms that have well-known brands (e.g. Heinz, Anheuser-Busch, Burger King) which can be turned around through “rightsizing”, eliminating waste, revamping the culture to be more performance orientated through better financial incentives, and recapitalization. Both Buffett and Munger defended 3G, sensibly arguing that all organizations need to be as efficient as possible. However, we think part of Berkshire’s “secret sauce” is its appeal to founders and family run organizations who want to sell to an owner like Berkshire who will leave them alone to run their business post-acquisition. They often sell at less than top dollar to Berkshire in exchange for this implicit promise. In turn, Berkshire gets an attractive price and strong management in place to continue running their organization. Where Berkshire seeks well run organizations to buy and leaves them alone, 3G buys poorly run businesses and then introduces their aggressive culture of performance. Berkshire does not have the skill set or DNA to take part in such major corporate reorganizations. How will prospective business sellers feel about Berkshire’s increased involvement with 3G? Will they be less willing sellers?
Berkshire is so large now that only true elephant-sized acquisitions will move its performance needle. Unfortunately, the valuations of publicly traded large companies have become increasingly pricey after the recent market run. It is hard to envision big further gains from valuation multiple expansion, especially if interest rates begin to inch higher. Most of the large companies that Berkshire would target operate in mature industries and already dominate their respective fields making it difficult to grow through further market share gains. Against such a backdrop, returns from organic growth will be modest. Barring another market correction, we believe one of the ways to generate above average returns from a group of fairly valued, slow growing companies is to use aggressive tactics like those employed by 3G. Whether investors believe these tactics are too aggressive or not, Berkshire’s growing association with 3G has the potential to change the perceptions (and the reputation) of both the company and Buffett. There are always tradeoffs that must be weighed. On balance, the 3G involvement makes sense for the reasons we outlined above but reputational issues must be considered. We agree with Munger’s “old fashioned principle” that the best way to earn trust is to deserve it by behaving well as you go through life.
Part 1 – “Always be open to good accidents”
Part 3 – “If people weren’t so often wrong, we wouldn’t be so rich.”
Part 4 – “If we continue with these interest rates, stocks will look very cheap”
Felix Narhi, 6 May 2015
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